The Hong Kong Stock Exchange is the world’s second biggest exchange, measured by its own market capitalisation. Call it the China factor. Yet as the mainland’s own exchanges get bigger, Hong Kong can’t count on winning prize listings forever. It’s time for a plan B.

Once, Hong Kong was the designated destination for IPOs of China’s state-owned companies, because mainland rivals were deemed too small. But now, China wants to develop an international financial centre on the mainland. Even Hong Kong stalwarts such as lenders HSBC and Standard Chartered are planning to issue shares over the border. The next big bank to list, Agricultural Bank of China, may eschew Hong Kong altogether.

When China publishes its budget report on March 5, Beijing may congratulate itself for achieving 8.7 percent GDP growth with a fiscal deficit that is just 3 percent of GDP. But the real cost of stimulating the economy has been much bigger – thanks to frantic borrowing by local governments.

State media reported that China’s local governments borrowed 3.8 trillion yuan ($556 billion) from banks last year, to keep the economy humming. They also raised 450 billion yuan ($65.9 billion) indirectly via the bond market. Add those debts to Beijing’s own, and the real 2009 fiscal deficit could be 15 percent of 2009′s GDP.

China may be returning to an old way of doing business. In the days before Chinese banks sought international partners, they were often backed by industrial companies. Now China Mobile is likely to pay $5.9 billion for a 20 percent stake in Pudong Development Bank, diluting the U.S. Citigroup’s 3.4 percent of the Shanghai lender.

The mid-sized bank needs new capital, since its core capital ratio was close the regulatory minimum threshold of 7 percent in September 2009. The new funds would increase that ratio by 1.8 to 4 percentage points, according to CICC, enough to support three years of lending growth.

It’s no secret that China would like to match its rising financial weight with a greater say in the institutions that oversee the global economy. That includes a larger formal voice in the International Monetary Fund.
For years, China has been shut out of influential positions at the IMF, which is dominated by the West. So the appointment of Zhu Min as a special adviser to Dominique Strauss-Kahn, the IMF’s managing director, is a welcome sign of change.
Beijing may have preferred a more senior position. When Zhu Min was promoted to be a deputy governor of China’s central bank late in 2009, the assumption in China was that he would soon become a deputy managing director at the IMF. Asia’s top job at the IMF has long been held by Japan.
China may have unseated Japan as the world’s largest holder of foreign reserves, but the IMF board is not ready to replace Japan just yet. This may be seen as entrenched interests resisting change. But it also reflects practical experience. When the IMF last year expanded its emergency borrowing program by $500 billion, Japan chipped in $100 billion before China committed providing $50 billion.
As an adviser, Zhu will not have direct influence in driving the IMF’s policy agenda. But he may have some impact on the margins, depending on how the managing director integrates him into work flow.
He will be able to offer guidance on how the IMF can improve its bonds with Asian emerging markets – a relationship that was strained by the IMF’s ill-perceived doling out of remedies for Asia during the 1997 crisis. A former executive at a large state-owned bank, he has first-hand knowledge of China’s financial system.
Strauss-Kahn has made it clear that he favors giving emerging markets a greater say in the running of the fund. But he cannot change the balance of power at the IMF, which has been the subject of long and protracted negotiations.
Zhu’s appointment may help speed up the process. But China is still some way from taking its place at the IMF’s top table.

Shanghai has had its first new issues disaster. XD Electric fell 1.4 percent on its first day of trading. That might not sound so bad, until you consider that Chinese initial public offerings in the last six months rose an average 80 percent on their first day. It might be a welcome sign that China’s stock market investors are become more discerning.

XD Electric, the first IPO of 2010, suffered from two headwinds. One was a general market pull-back on fears China will begin monetary tightening. The Shanghai Composite Index has fallen 5 percent since the electrical equipment maker priced its shares a week ago, with heavy equipment firms down 8 percent. XD Electric was priced at the top of its indicated range, a 26 percent price-to-earnings premium to the market. Taking that into account, XD Electric’s performance is not as bad as it looks.

Hedge funds watching China’s markets are licking their lips at what they see as the best shorting opportunity since Enron. But while plans to allow short-selling are imminent, this won’t be a bear’s picnic. Beijing’s plans to allow two-way equity bets will give foreigners little chance. Borrowing individual stocks will be tricky, even for locals.

After many countries such as the United States and UK put more severe restrictions on short-selling, China is taking the contrarian view. The short-selling regime has been three years in the making. The goal is to allow investors to express a different view on the market, and prevent market valuations getting overly stretched.

Chinese Premier Wen Jiabao once said 2009 would be China’s toughest economic period in fifty years. He wasn’t thinking ahead. In 2010, policymakers face a seemingly impossible mission – continuing 2009’s growth of 8.7 percent while curbing resurgent inflation. December’s figures show the government is already behind the curve.

The annual inflation rate for consumer prices was a seemingly mild 1.9% in December. But that number understates the threat. The consumer price index excludes the rapidly rising cost of property. And year-on-year changes miss the most recent trend. In the most recent month, prices rose 0.8 percent – a nerve-wracking 10 percent annualised rate.

A month before China ushers in the year of the Tiger, its central bank has begun to address the effects of its roaring liquidity boom. It is encouraging that the authorities in Beijing are alert to the threat of an overheating financial system. But with so many countervailing forces, the liquidity tiger will not be tamed so easily.

Markets yelped Tuesday after the central bank raised the minimum ratio of capital to loans at banks by half a percentage point. But this amounts to little more than scooping water out of the sea. Some 1 trillion yuan ($146 billion) of government bills mature in the next two weeks. If they are not rolled over, three times more money would flow into the system than the reserve hike will leech out. Then there are foreign speculative flows – an estimated 378 billion yuan in the fourth quarter of 2009.

China’s sovereign wealth fund is to have its coffers restocked possibly with as much as $200 billion. This could end up being a further boost for the global commodities sector.

China Investment Corporation had $297 billion of assets at the end of 2008. Now its cash reserves need replenishing after a spending spree this year, according to people close to the fund. CIC invested as much overseas each month in 2009 as it did in all of 2008. Investments included a further $1.2 billion in Wall Street bank Morgan Stanley , and a spate of resources deals in Canada, Indonesia, and Mongolia.

China has been reluctant to give way on climate change issues, as the stalemate at the Copenhagen summit shows. But the desire to be tough negotiators shouldn’t get in the way of green initiatives. China may have more to gain than most from a global push towards a greener world, both as a heavy commodity user and as an exporter into a potential $1 trillion market.
China is already by far the world’s largest producer of solar panels, accounting for more than 40 percent of global supply. Among the world’s top 15 wind turbine manufacturers, three now hail from China, each accounting for about 4 percent of global market share.
The market for green technology could reach $1 trillion by 2013, according to PricewaterhouseCoopers. If China could capture ten percent of that, which could prove conservative based on its share of solar and wind, it could reap $100 billion. That’s what all of the G77 developing countries have demanded from rich nations during the Copenhagen talks.
Meanwhile, China has an opportunity to replace its falling low-value exports with a more sustainable, high-value green alternative. Developed nations would struggle to match the “China price” — a result of a large domestic market, state subsidies, cheap loans and low-cost labor. That should help China achieve another goal: nurturing domestic champions.
There is another reason China should support a world accord on low-carbon energy: it is one of the world’s biggest commodity consumers, and the second-largest user of oil. That leaves the country worrying about energy security, and heavily exposed to spikes in commodity prices, such as the 39 percent rise this year. Reducing a reliance on the fickle fuel markets makes a green compromise more than worth it.